What is a Cash Credit And How Does it Work?
Cash Credit are loans that are extended to companies to fund their working capital requirements. Cash-strapped businesses find it tough to carry on their day-to-day operations, and they end up with massive debts or the worst-case scenario, closure. Banks and other lending institutions offer several short- and long-term loans and financing (cash credit) to help businesses meet their liquidity needs.
What is a Cash Credit?
Cash credit is a working capital loan that businesses can take out. It is the credit given to organisations for some time above their current account balance. Businesses can borrow up to the agreed or authorised borrowing limit over and above their account balance. The bank would charge interest only on the amounts withdrawn, not the whole borrowing limit, according to its norms and agreed agreements between the borrower and the lender.
What Are the Factors of Cash Credit?
Numerous factors decide the borrower’s borrowing limit:
- The borrower’s past track record
- The funds requested by the borrower
- The borrower’s repayment capacity
- The business organisation’s current assets and current liabilities position
- The collateral or security is against the cash credit facility
- The borrower’s credit profile
Key Features of Cash Credit
- Type and Nature of the Loan: As previously stated, a cash credit facility is a short-term loan given to businesses to cover their working capital requirements. It is a type of secured loan. It can be processed more quickly than unsecured loans.
- Tenure: A borrower is granted a cash credit facility for 12 months at once. This tenure can also get determined every quarter in some situations. This period can get extended according to the parameters agreed upon by the borrower and the lending bank.
- Payback Schedule: The payback schedule for a cash credit facility is very flexible. Borrowers can return this loan over time via EMIs, either monthly or quarterly, as negotiated by both sides.
- Interest Charged: The interest charged on a cash credit facility is lower than the interest charged on standard business term loans as it does not get charged on the total amount of the borrowing limit. It only gets applied to the amount borrowed throughout the loan’s term. Calculation of interest is on the account’s daily closing balance.
- Collateral Required: Bank usually requires collateral to lend this facility to businesses. The borrowing limit, in most cases, is set as a percentage of the available collateral. In most circumstances, a company’s current or fixed assets, or inventory, are kept as collateral for a cash credit line.
- Charges at the Bank: Even if the borrowers do not use the cash credit facility given by the banks throughout the loan, the banks levy a fee or charge for providing it to them. This fee is for money the bank keeps in reserve for the borrower for the cash credit facility, funds that the bank otherwise would have used elsewhere.
- Withdrawals: During the term of the facility or this loan, the business entity can make unlimited withdrawals.
How Does Cash Credit Work?
A cash credit facility is a type of short-term loan. As a result, cash credit must reflect on the liabilities side of the balance sheet under the heading Short Term Loans, as per the accounting rules and Accounting Standards guiding the preparation of the books of accounts and financial statements.
Suppose Company A is a phone manufacturer that owns and operates a facility where it spends money on raw materials before turning them into completed goods. In contrast, finished goods inventory does not get sold immediately. The company’s capital gets trapped in stock. Company A accepts a cash credit loan in order to pay its expenses. This is done while it waits for its finished goods inventory to convert into cash, allowing it to continue operating without a shortfall.
Eligibility for Cash Credit Facility
Cash credit is credit extended to a person more than the amount available in their account, with interest charged on the cash borrowed. Any of the following people are qualified to take advantage of this service.
- Individuals
- Partnership Firms
- Limited Liability Partnerships
- Registered Trusts
- Private Limited Companies
- Public Limited Companies
- Co-operative Societies
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Documents Required For Cash Credit Facility
The KYC documents, as well as a few additional documents that determine the nature and sustainability of the firm, are necessary to use this service. Below is a list of documents.
- PAN Card
- Identity Proof of the Applicant
- Address Proof of the Applicant
- Recent Photographs
- Bank Statements
- Application form
- Financial Statements
- ITR and GST Returns
- Business evidence
- Business address proof
- Partnership Deed/ Memorandum and Articles of Association (if applicable)
- Collateral/security information
- Existing loan/liability information
- GST Certificates
Benefits of Cash Credit Facility
The ability to use cash credit is a great help to businesses. The following are some of the advantages that this facility provides to enterprises.
- A great way to meet your working capital requirements.
- Because this facility is like a secured loan, it permits easy access to cash or liquidity.
- It also allows for faster processing.
- Renewable term
- Flexible repayment choices
- Lower interest payments because only the amounts borrowed from the total limit extended are subject to interest.
- Multiple withdrawals
- The interest on these loans is tax deductible.
Disadvantages Of A Cash Credit
Cash credit facilities, while considered to be a helpful and advantageous form of lending for borrowers, may have some drawbacks, which are listed below:
- Interest rates are higher than standard loan options.
- Because this facility is provided based on the business’ past track record, it becomes challenging for newer businesses to obtain such a facility.
- Renewal of cash credit facility each time after completion of 12 months can make it an inconvenient process and will require extensive paperwork every time.
The Cash Credit must be kept distinct from the other accounts and always show a credit balance.
Difference Between Cash Credit And Overdraft
Cash credit is a short-term business loan provided to organisations to maintain working capital, and overdraft facilities are for individuals and businesses who want to withdraw more than their available funds in their bank accounts.
A few differences between overdraft and cash credit are as below:
| Cash Credit | Overdraft |
| Definition | |
| Cash credit is a short-term loan granted to firms by banks or financial organisations to keep their working capital afloat. | An overdraft facility is a loan to an individual or a business depending upon their banking relationship. In this arrangement, an individual can withdraw an amount more than his available balance up to a pre-decided limit set by the bank, as long as the bank’s laws get followed. |
| Purpose | |
| Provision for cash credit is for maintaining the working capital of the business. | Provision for Over draft is for meeting short-term obligations of individuals or businesses. |
| Rate of Interest | |
| The borrowing rate is lower than the interest rate on an overdraft. | The interest rate is higher than the cash credit. |
| Need of account | |
| The creation of a new account is compulsory. | An existing account is sufficient to obtain an overdraft. |
| Calculation of Interest | |
| Interest is calculated based on the entire amount that is withdrawn | Calculation of Interest is only on the amount that gets availed |
| Duration of loan | |
| The duration of the loan is generally one year. | The loan term can be monthly, quarterly, half-yearly, or yearly. |
Final Word
Cash credit is a short-term loan offered by banks or financial institutions to firms to keep their working capital afloat. A borrower is granted a cash credit facility for a period of 12 months at a time. The interest imposed on a cash credit facility is not on the total amount of the borrowing limit, which makes it a better option than standard business term loans. It only gets applied to the amount borrowed throughout the loan’s term. The cash credit facility has a reasonably flexible payback plan.
FAQs on Cash Credit
Ans: A Cash Credit is a credit limit given to debtors. Borrowers can withdraw funds several times during the term until they do not exceed the CC limit.
Ans: Borrowers get a cash credit facility for 12 months, which can get renewed at the end of the term.
Ans: A cash credit facility’s interest is calculated solely on the amount withdrawn (the account’s daily closing balance), not the overall borrowing limit available to the borrower.
Ans: Cash credit is a short-term loan that one can classify as the borrower’s current liabilities.
Ans: Inventory or stocks, debtors, or any other current assets, as well as fixed assets in some situations, can be used as security for a cash credit facility. Collateral for non-manufacturing firms can be any asset agreed upon by the lender and the borrower.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
